So
says Jeremy Grantham, co-founder of Boston-based investment firm Grantham,
Mayo and Van Otterloo, now known as GMO. Some call him the philosopher
king of Wall Street because of his highly insightful views on markets
and the economy, usually with a longer-term perspective. In a profession
of touts, fast-buck and scam artists, Grantham's commentaries are
notably refreshing. They're detailed, scholarly, sober, clear and
especially important at a time of unparalleled excesses, great economic
uncertainty, voices ranging from gloom and doom to blue skies and
all clear ahead, so who knows what to believe. Few people sort things
out better than he, and whether right or wrong, he makes consummate
sense and should be taken seriously.

He calls
his latest commentary "Immoral Hazard" and takes straight
aim at the perpetrators. It's not the first time, and with good reason.
Bad policy yields bad results with former Fed Chairman Greenspan Exhibit
A.

Grantham
notes: "It's not that the former Fed boss...was incompetent that
is remarkable. (It's that even now) so many people (still) don't seem
to get it." Do they "just believe high-quality, self-justifying
blarney?" Or do they think top jobs ipso facto "attract
great talent by divine right?" Often, the most important jobs
get "mediocrities" like Greenspan and the current White
House occupant. Even worse, Washington is infested with them.

Grantham
first learned of Greenspan in the late 1960s when he headed economic
consulting firm Townsend-Greenspan & Co. Even then, his assessment
was unsparing: "To be brutally honest, he was considered run
of the mill by anyone I knew then or have met later who knew"
of his work. Consider his "famous" January 1973 call that
"it is rare that you can be as unqualifiedly bullish as you now
can." It was right at the start of a punishing recession and
60% two-year market decline in real terms, second only at the time
to the 1929 crash.

Never one
to equivocate, Grantham cuts to the chase and draws blood: Greenspan's
call "was one of the first of a long line of terrible prognostications
for which he has remarkably 'not' been remembered," except by
a few historians and analysts like Grantham. He seemed to pop out
of nowhere to become Fed Chairman in 1987, not for his professional
skills but for plenty of political ones. The Greenspan years and what's
so far followed haven't been "our finest hour in the US."

A smattering
of skilled leaders handled things way back compared to the "rudderless"
kind under Greenspan and today. Moments (far too few) showed "vision,
leadership and backbone." They then gave way to political opportunism
and "easy paths taken" for short-term gains - most notably
since the Reagan era. Referring to when Greenspan became Fed Chairman,
Grantham continued saying we're "get(ting) ready to celebrate
the 20th anniversary of the Great Moral Hazard." Asset bubbles
are tolerated because of who wins and loses. If managed well, speculators
and Wall Street profit hugely, bail out at tops (the old pump and
dump scheme), then let the public take the pain. No problem though
if they miscalculate. Fed Chairmen like Greenspan and the current
maestro step in with bailouts.

It's called
"moral hazard," and the term goes way back - to the 1600s.
English insurance companies then used it in the late 17th century.
In the modern era, it got more study in the 1960s, but at the time
didn't imply fraud, immoral behavior or outsized excess. Economists
used the term to describe market inefficiencies when risks are displaced.
It was before what became known as the "Greenspan put,"
or the idea that Fed Chairmen provide insurance - to bail out investors
who take imprudent risks, so take even greater ones since winning
is always guaranteed. But only for high-rollers.

Moral Hazard
101 - A Brief Case Study

Take Long
Term Capital Management (LTCM), for example, and its dream team management:

-- a former
highly respected Salomon Brothers fixed income chief who became tainted
by the firm's auction-rigging scandal; no matter, he remained highly
regarded by Wall Street;

-- a former
Fed Vice-Chairman; and

-- two
economics Nobel laureates.

They played
high-stakes poker with little regulatory oversight and used their
good names to do very risky things - like putting on interest rate
swaps at market rates for no initial margin; borrowing 100% of value
of top-grade collateral held; using that cash to buy more securities,
then using them as collateral for more borrowing. In other words,
it was a scheme to theoretically leverage to infinity, LTCM practically
did it, and for a while it worked.

Things
began unravelling in 1998. It started in July when Salomon Smith Barney
announced it was liquidating its dollar interest arbitrage positions.
LTCM took a hit, then things got worse when in August Russia declared
a moratorium on its rouble and domestic dollar debt. Panic ensued,
it spread to other markets, risky investments fled to high quality
ones, then they were sold to raise cash.

LTCM was
one of many large investors affected. By September, it dropped 52%
in value and needed new capital to avoid a dilemma that could impact
all of Wall Street if not addressed. LTCM's balance sheet assets were
leverage thirtyfold to $125 billion, then tenfold more by off-balance
sheet transactions for a total valuation of around $1 trillion - or
too big to fail. If they folded, a financial panic could ensue, so
the situation was critical. Enter the Fed after some initial high-stakes
maneuvering failed. It engineered a multi-billion dollar bailout to
avoid a greater financial market collapse.

It worked,
but it's no way to run an economy. Bad examples keep getting repeated
and each time show up worse. That's precisely today's dilemma. The
stakes are enormous. No one for sure knows to what degree, and there's
even less assurance how things will play out.

Minsky
on Markets

He's passed
but surely smiling and saying I warned you. His economic writings
were mostly ignored in the prosperous 1980s and 1990s, but current
market turbulence proved him right. He constructed a "financial
instability hypothesis" building on the work of John Maynard
Keynes. It showed how speculative bubbles grow out of outsized greed.
Finally, asset values collapse in the end-game part of a seven-stage
up-then-reverse journey downward. It's a "Minsky Moment"
when euphoria turns to panic, investors bail out, and meltdown ensues.

That's
how markets reacted to the Greenspan-caused tech bubble. They sold
off hugely, then reinflated from outsized monetary and fiscal stimulus.
Last summer, they peaked, dropped sharply, stabilized in April after
a lesser Minsky reversal, but there's no way to know if it's over.
Grantham doesn't think so. Neither do others. More on that below.

Economist
Michael Hudson Cuts Through the Clutter

Hudson
is an economist and President of The Institute for the Study of Long-Term
Economic Trends (ISLET). He's also a Distinguished Research Professor
of Economics, a former Wall Street financial analyst, and a no-nonsense
critic of the current economic environment. He notes how recent events
show that "economic royalists" and "money changers"
run things and have "mismanage(d) our economy into dire straights
of unprecendented risk - (a combination of reckless) debt creation,
euphemized as 'leveraging' and 'wealth creation.' "

Few regulatory
checks remain, and anything goes "under the guise of 'saving
the system.' " If money manipulators hadn't endangered it, no
fix would be needed. Now with systemic trouble of undetermined proportions,
trillions of dollars are being misdirected. They're going for wars
and bailouts instead of helping beleaguered homeowners who were manipulated
for profit, face possible foreclosure, job loss, and likely hard times
ahead.

Hudson
says what's going on is "an economy-wide Ponzi scheme (for) creditors
to lend debtors enough money (for their) interest costs so as to keep
current on their loans." The idea was for various asset prices
(stocks, bonds, real estate) to be inflated enough so debtors could
pledge them as collateral at higher market valuations for more loans.

It worked
as long as valuations rose. When they fell, all bets were off, and
here's how trouble started and spread:

-- cracks
in the multi-trillion dollar US securitization markets showed up last
summer; they created liquidity crises for two Bear Stearns hedge funds;
they were heavily into sub-prime mortgages; Bear Stearns was a Wall
Street outlier; it was much unloved on the street, notorious for taking
outsized risks, and that made it very vulnerable for a run on its
assets when the opportunity came; it happened in March and forced
the firm to sell out for pennies on the dollar after 85 years in business;

-- the
initial damage spread to a little-known German bank, IKB; it forced
the European Central Bank (ECB) to provide large amounts of liquidity
to stem the damage;

-- it became
apparent that trouble was systemic; it could touch down anywhere and
likely hardest where greatest risks were taken - in America; and

-- intervention
wasn't working; panic didn't stop; reserve hoarding took hold instead;
and a run on commercial paper began - the kinds international banks
issued in Structured Investment Vehicles (SIVs).

The bottom
began to fall out, and the problem was how to stop a growing debacle
from becoming catastrophic. The solution, of course, was "immoral
hazard" by bailing out transgressors, and the bigger they are,
the greater the bailout amounts. Hudson calls it a "trillion-dollar
bailout of bad mortgage debt" while homeowners go begging.

It began
in March with heaps of hyperbole selling it. Multi-billions poured
out. Money supply growth exploded. It now averages a near-monthly
18%. Deficits are mounting, and fiscal spending is just as outsized,
but not much of it reaches households even with the so-called "rebate."
In the meantime, real wages keep falling. Oil and food prices are
skyrocketing. Real unemployment tops 12%. Consumer inflation is nearly
as high, and real GDP (not the phony official number) hovers around
-2%. Most other economic numbers are just as worrisome, so manipulating
magic fixes them.

We're in
uncharted territory, problems are huge, they're systemic and structural,
and Hudson says "the Fed and Treasury officials seem to be making
up new rules on a daily basis - that receive only....perfunctory"
congressional oversight. Speculation is being rewarded, anything goes,
and bailing out Wall Street and big banks takes top priority.

It gets
worse. It costs trillions. No one knows where it will end or if it
will work, and there's nothing left over for Social Security, Medicare,
Medicaid, and all other essential social and national infrastructure
needs.

Hudson
puts it this way: "The historic road to serfdom is that of debt
peonage to a financial oligarchy concentrating wealth in its own hands....The
problem for society....is that finance finds its major gains to lie
not in raising living standards, but in promoting a free lunch for
its customers -- while turning corporate profits, monopoly rent-seeking
and real estate price gains into a flow of interest to itself, by
advancing the credit to finance the purchase of these assets and privileges."

The only
way out is to "scale back existing mortgages (especially ones
with negative equity) to reflect the plunge in property values today."
Once principal is "reduced to realistic levels," fixed rate
mortgages would replace ARMs.

Financial
institutions won't accept this or whatever other ways it costs them,
and therein lies the problem. Blaming victims is much simpler along
with bailing out culprits - when they're too big to fail. Hudson calls
for some high-octane populism to change things. Unfortunately, not
a hint of it is in sight, and debt levels are so high they "cannot
be paid....given the nation's heavy military and trade deficits."
It's hammered the dollar and "rais(ed) dollarized prices for
oil and other raw materials."

It gets
worse. Foreign central banks and investors keep funding our excesses,
and US spending, of course, depends on them. The more they lend us,
the more we need in a never-ending dependency cycle. It bankrupted
Medici bankers in the Renaissance era and got Adam Smith to conclude
that governments don't repay outsized debts. They either default,
declare a moratorium, or repudiate them. Not fit subjects for discussion,
but you can bet foreign debt holders weigh them as they debate whether
to keep the daisy chain going.

It's got
plenty of US investors concerned as well, and a notable one is bond
guru Bill Gross. In an April commentary he wrote: In his judgment,
"the private credit markets have forfeited their privileged right
to operate relatively autonomously because of incompetence, excessive
greed, and (at times) fraudulent activities."

In an earlier
Financial Times interview he also criticized government quick fix
schemes. He further blasted hedge funds as "unregulated bank(s)"
and a "con" and said complicated financial instruments "exacerbated"
credit problems, and over-leveraging "lead(s) to an implosion
at the edges....of this new financial marketplace."

He's also
very worried about declining home prices that many on Wall Street
publicly pooh-pooh. He calls a 20% valuation decline "much more"
of an economic shock than falling equities "because the amount
of homeowner leverage is so much greater. A 20% negative adjustment
not only wipes out all ownership equity for millions of Americans,
it turns their homes 'upside down' - incentivizing them to let their
gardens grow weeds instead of lettuce." He believes systemic
crisis is possible if the decline isn't stopped. He's not alone in
that judgment, but few agreeing get heard.

Consider
damage already done. The current Case-Schiller Index shows home prices
declining at a 32% annual rate. A year ago, it was 8%. The risk is
a huge 4.6 million home inventory or nearly double the 2.6 million
past 20 year average. Even more worrisome is that 2.27 million homes
sit empty and that's besides all the others banks own from foreclosures.
It's double the year ago number.

If these
properties keep deflating and hit the dangerous 20% level Gross mentions,
millions will lose their equity, consumption and credit will be hit,
and banks will keep writing-off greater amounts no one wants to contemplate.
Robert Shiller believes home prices may equal or exceed the 30% drop
of the 1930s. That's $6 trillion in today's dollars, or $80,000 for
every US homeowner. The Fed can keep injecting liquidity but only
for so long, and it may not work. If bank losses are great enough,
they'll need all they can get to stay afloat, but for some it may
not be enough. Not a pretty picture and no way to know how bad things
may get.

Placing
Blame Where It's Due According to Grantham

Grantham
looks back at 2007 and awarded three prizes for "odd prognostications."
They're named in Greenspan's honor. First prize went to Citicorp's
CEO Chuck Prince for enthusiastically taking on more credit at a time
markets were over-extended and peaking. He subsequently wrote off
billions of worthless assets, $17 billion in first quarter 2008 alone,
risked the bank's solvency, and got himself replaced by a new CEO.

Current
Fed Chairman Ben Bernanke took second prize for "incomprehensible
misreading of obvious data by an apparently well-informed source."
In late 2006, he said what he now regrets (or should) - that "US
housing prices merely reflect a strong US economy." His cohort
at Treasury, Hank Paulson, got third prize for his spring 2007 comment
that subprime problems were "contained."

Not if
you own one or too many of those junk assets written down to a fraction
of their original value. Grantham calls the crisis the most important
one since World War II. It's more global than others. Its tentacles
are everywhere. Speculative greed and broad asset overpricing caused
it. Loose regulatory and irresponsible Fed policies allowed it. Perpetrators
point fingers elsewhere, and no one's got backbone enough to fess
up to their to their own mistakes and transgressions.

Before
this ends, according to Grantham, it's "likely to make the S
& L crisis look contained." As a per cent of GDP, write-downs
this time are on the order of two to three times greater now than
then. But there's no precise way to know their full impact or to what
degree monetary and fiscal stimulus will contain the damage or delay
its final resolution. They won't be papered over, and writer/economist
William Engdahl puts it this way:

Greenspan
was a tool of the monied interests who gave him his job. He "knew
who buttered his bread" and returned their favors manyfold. He
engineered many crises and used them all to "advance and consolidate
the influence of US-centered finance over the global economy, almost
always to the severe detriment of the economy and broad general welfare
of the population." His 18 year tenure was undistinguished to
say the least. "It can be described as rolling the financial
markets from successive crises into ever larger ones..."

It remains
to be seen if his "securitization revolution was a 'bridge too
far,' " spelling the beginning of the end of US dominance as
an economic power. The "true significance" of today's crisis
(nowhere near resolved) lies right in his lap. Engdahl lists his menu
of malpractice in serving the "Money Trust," meaning Wall
Street and big banks. In each case, it yielded big short-term gains,
greater long-term losses, and successively greater crises. A new Fed
Chairmen has to solve them. Bailout is his strategy. It may help in
the short-term. The jury is still out. The policy is flawed. It assures
greater crises ahead, and at some point the music stops.

Bernanke
may end up being too smart by half. We're awash in problems that one
analyst calls three simultaneous imploding bubbles:

Grantham
also takes aim at them and sees lots more write-downs and defaults
ahead before it ends. He cites a longer-term problem as well - "that
all debt standards fell so that losses will accumulate right across
the entire credit system." Even worse, it came at a time equities
were overpriced, still are, and particularly higher-risk ones. Further,
"profit margins are spectacularly above average" in some
sectors, margins are being squeezed, and markets finally caught on
that "all risk is dangerous."

Grantham's
research shows that all markets eventually revert to their means and
for months have been "well into a massive repricing of both risk
and asset prices" to get there. Before it started last July,
we reached "the lowest risk premium, by far, ever recorded."
It needs lots of heaving lifting to return it to more normal levels.
And, of course, it's a painful process, a drag on the economy, and
will likely take years to fix. In Grantham's judgment, through 2010
"to clean house completely," and when it ends "the
amount of write-downs (may likely) start with a 'T.' "

Blame it
on a Fed Chairman whose name starts with "G," and Grantham
has been unsparing on him before. Referring to the 1990s dot.com and
tech excess, he blamed him for engineering the largest ever stock
market bubble and bust in history through incompetence, timidity,
dereliction of duty or a combination of all three. It didn't matter
because Wall Street types made fortunes, then got plenty of early
warning to exit to let small investors take the pain.

Undeterred,
Greenspan was at it again in the current cycle that's now being unwound.
But this time, multiple bubbles were created, with housing and mortgage
ones most affecting households. Grantham (like Gross) calls them "much
rarer and more dangerous than stock bubbles" because they affect
so many people. Even worse, with over half of all housing wealth borrowed
and "on much less credit-worthy terms," it's very much "more
dangerous than normal."

It's the
Fed's job to watch over:

-- mortgage
quality;

-- the
soundness of repackaging mortgages; and

-- off
balance sheet commercial banking that should have been stopped or
curtailed.

"And
what did Alan Greenspan do this time? Absolutely nothing" except
whine about a little excess in housing when it was already out of
hand. Even then he implied not to worry because "the housing
boom will soon simmer down." And Bernanke is even more feckless
with comments like "The housing market merely reflects a strong
US economy." Grantham portrays him as a Greenspan clone, just
as incompetent, and someone having "extraordinary faith in efficiency
to the point of denial." Above all, like Greenspan, he's there
to serve the "Money Trust" that appointed him.

And he's
done it since taking over. First, by "stimulat(ing) at all costs"
and repeating the same mistakes as his predecessor. Grantham calls
2008 "the year of Santayana: we ignored history and (are) condemned
to repeat it." Housing price deflation is its most notable feature.
It's what affects households most, and that, in turn, reverberates
through the economy. Greenspan and Bernanke paid it no heed. Each
now accepts no blame, and Grantham calls it "shameful."
It's far worse than that at a time people are suffering, and the current
Fed Chairman gets accolades for bailing out bankers while paying only
lip service to homeowners.

By creating
asset bubbles, Fed policy caused their dilemma, and Grantham believes
their deflating may be the greatest of all threats to financial and
economic stability. It stands to reason that efforts must be made
to avoid the worst possible outcome. That means curbing speculation
is key. Minsky was right that short of that financial crises are inevitable
and excess is always the cause.

Grantham
sums it up saying: it's important or even vital "to our financial
well-being that the Fed recognizes a responsibility to move against"
this behavior that comes with a huge price. Greenspan's response:
"I have no regrets on any of the Federal Reserve's policies that
we initiated...." Grantham calls that "chutzpah that even
Paul Bremer would have to admire."

Engdahl
calls it a "financial tsunami." It triggered a "crisis
of confidence." High-risk securities were most affected. So were
sub-prime mortgages. Then the whole "edifice of securitized debt"
began unravelling, triggered by its weakest link collapse. Its effect
is global and "a crisis not even comparable to the 1930s Great
Depression."

High-quality
municipal debt got hit. Interest rates on them "rose to the highest
ever relative to Treasuries." It makes financing unaffordable
and caused states and local agencies to "pull out of the $330
billion floating (auction-rate) market where costs have doubled since
January." New York and London bond fund managers say it's the
worst they ever saw. High interest rates aggravate fiscal crises even
with the Fed cutting fed funds and discount rates. Some call it pushing
on a string. Time will tell if it'll work. Engdahl is dubious. He
sees depression spreading. It creates "a self-reinforcing downward
spiral. The process is in its early stages...."

With market
turbulence somewhat quieted after a sharp April rebound after months
of declines, unanswered questions remain. Is it a lull, a turnaround,
or the eye of the storm before its harshest side hits? Grantham and
Engdahl see trouble. Bernanke's fingers are crossed. European central
bankers as well, while Americans fear losing their homes and jobs
the longer the crisis goes on and deeper it gets.

Direst
forecasts have it in its early innings with the worst of things ahead.
Only in the fullness of time will we know, but some things are clear.
None of this happened by chance. Nor should it have in the first place.
A combination of financial malpractice, outright fraud, and greed
are to blame. The same mistakes keep getting repeated. The costs keep
going higher. Sooner or later they matter, and some day it'll be too
late to fix them. Some day may be closer than smart money folks think.
Stay tuned, be cautious, and ignore Fed Chairmen and politicians promising
miracles. If things were sound and improving, they wouldn't have to
keep reminding us.

Stephen
Lendman lives in Chicago and can be reached at lendmanstephen@sbcglobal.net.

Also visit
his blog site at sjlendman.blogspot.com and listen
to The Global Research News Hour on RepublicBroadcasting.org Mondays
from 11AM to 1PM US Central time for cutting-edge discussions with
distinguished guests. Programs are also archived for easy listening.

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